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Q1 results are in, but Colgate-Palmolive executives are keeping an eye on raw material costs.

April 29, 2011

Editor

Consumers continue to snap up Colgate toothpaste, toothbrushes and soon, Sanex deodorants and shower gels. And that’s a good thing for parent company Colgate-Palmolive that, like so many other CPG companies, is keeping a wary eye on raw material costs.

That wariness comes at a time when first quarter sales were good. Colgate’s net sales rose 4.1% to $3.994 billion. Global unit volume grew 2.0%, pricing declined 0.5% and foreign exchange was positive 3.0%. Organic sales (Net sales excluding foreign exchange, acquisitions and divestments) grew 1.5%.

Colgate executives were pleased with the results, noting that the company’s share of the global toothpaste market strengthened to 44.7% year to date, up 0.6 share points versus year ago. Colgate’s global leadership in manual toothbrushes also rose during the quarter with its global market share in that category reaching 32.4% year to date, up 1.0 share point versus year ago.

First quarter net income was $576 million and diluted earnings per share was $1.16. In contrast, the company reported $357 million and $0.69, respectively, which included a one-time, non-cash after-tax charge of $271 million related to the transition to hyperinflationary accounting in Venezuela as of Jan. 1, 2010. Excluding the 2010 Venezuela hyperinflationary charge, Net income and diluted earnings per share decreased 8% and 4%, respectively, versus first quarter 2010.

Reflecting the significantly higher cost environment, we expect gross profit margin to remain at around the first quarter level throughout the rest of 2011,” said Ian Cook, Colgate’s chairman and CEO in a statement. “We continue to be sharply focused on our aggressive cost-saving initiatives and anticipate that the benefits from those programs combined with our global pricing efforts will help us achieve our profit target of mid-single digit earnings per share growth for the year, excluding the 2010 Venezuela hyperinflationary charge noted above.

Portfolio Changes

In March, Colgate agreed to buy Unilever’s Sanex personal care unit for about $940 million, marking its biggest purchase in more than a decade to expand in deodorant and body wash overseas. At the same time, Colgate agreed to sell its Colombian laundry detergent business to Unilever for $215 million. Sanex, which Unilever had to sell to allay European Union competition concerns, generated sales of about $260 million last year. These moves are expected to have an accretive effect on a combined basis of approximately 4% on total company earnings in 2011, due entirely to the one-time gain on the detergent business sales and a positive effect on earnings in 2012 of approximately 1% from growth and efficiencies of the Sanex business.

Colgate plans to sell $500 million of notes in its first bond offering since it agreed to purchase Unilever’s Sanex personal-care unit. The company will split the sale evenly between three- and six-year notes, said a person familiar with the transaction. The three-year notes may pay about 30 basis points more than similar-maturity U.S. Treasuries while the six-year securities may yield a spread of about 80 basis points, said the person, who declined to be identified because terms aren’t set. Colgate has $3.2 billion of long-term debt, compared with $2.8 billion at the end of December, according to its most recent quarterly filing.

The Sanex acquisition is Colgate’s first since 2006 as Cook aims to expand into more profitable products. The move gives Colgate, which generates more than 80% of sales outside North America, a foothold in key parts of the personal care market in Western Europe as a result of the transaction.

The past five years have yielded 275 deals for personal care companies globally. The buyers in 25 of those deals paid a median of about 1.1 times their targets’ sales over that period, according to data compiled by Bloomberg. Colgate paid about $1 billion for Latin American toothpaste maker Kolynos Oral Care in 1995.

Oil’s Impact

While Colgate has made moves to build a higher-margin portfolio, like so many other players, the company can’t do much about higher raw material costs. Cook said he expects commodity costs to rise 11-13% as the year unfolds—up from previous estimates of an 8% to 10% increase. For the year, Colgate has modeled oil at $100 to $110 per barrel. But as of April 30, the price of oil stood at nearly $113 a barrel.

However, Colgate has been able to limit commodity cost impact via several internal measures, such as improving efficiency. For example, a new shared service center in Warsaw, services 27 European countries, which changes the processes used to get work done, which brings further savings and efficiency.

At the same time, Cook noted that promotional pricing issues continue to impact results—albeit at a slower rate.

“We continue to see elevated levels of promotional activity, and we continue to meet that promotional activity where necessary,” observed Cook. “But we think the pricing we have in, we can take in the context of maintaining our volume momentum.”

He noted that even as unemployment remains high, and the underemployment rate is even higher, which has consumers economizing. Meantime, the high cost of gas has led to substantial shifts in consumer shopping behaviors, both by types of stores and how frequently they purchase.

New Product Launches

One way to counteract promotional activity is to roll out novel products. Cook maintained that the relaunch of Colgate Total has helped consolidate the company’s leadership market position on toothpaste, adding 20 basis points year-over-year. Last year, Colgate launched Ultra Palmolive Antibacterial Dish Liquid, which is EPA approved to kill 99.9% of E. coli, salmonella and staph on dishes and non-porous surfaces in 30 seconds.

Ultra Palmolive Antibacterial Dish Liquid

In the current quarter, Cook is confident that the rollout of new Colgate Max variants will provide a lift to sales.

Looking ahead, Cook maintained that Colgate will have several product launches in the third quarter

“The big factor for us in North America is the timing of our innovation, which last year was very much first quarter oriented and this year is very much third quarter oriented,” said Cook. “I think you'll be quite excited by some of the innovation you see in the second half.”

Cook is excited too, by the Sanex acquisition. Couple that purchase with the sale of the detergent business in Colombia, and Cook termed the move as fitting exactly to what Colgate looks for in an acquisition in the sense that it is strategic, it gives Colgate strength in a business that is important to the company and it is a premium-priced product with a simple and consistent healthy skin positioning and the consumer strength that comes with that.

“And we were able to signal our intention to buy that business at the same time as we sell a lower gross margin, inherently lower growth detergent business,” he added.

Cook noted that Colgate has de-emphasized home care in recent years, in favor of higher-margin oral care, personal care and pet care businesses, but he noted, like as a fourth child, “we don’t love it any less.”

“We like the business. And we think we can bring the innovation necessary to compete in that business, and we have no intention of selling that business,” he insisted.

For a full transcript of the Colgate Q1 call, visit: www.seekingalpha.com